Huashi Group Holdings Limited's (HKG:1111) robust recent earnings didn't do much to move the stock. We believe that shareholders have noticed some concerning factors beyond the statutory profit numbers.
Zooming In On Huashi Group Holdings' Earnings
Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. This ratio tells us how much of a company's profit is not backed by free cashflow.
As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".
Huashi Group Holdings has an accrual ratio of 0.48 for the year to December 2024. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. Even though it reported a profit of CN¥80.6m, a look at free cash flow indicates it actually burnt through CN¥54m in the last year. We also note that Huashi Group Holdings' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥54m.
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Huashi Group Holdings.
Our Take On Huashi Group Holdings' Profit Performance
As we discussed above, we think Huashi Group Holdings' earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that Huashi Group Holdings' underlying earnings power is lower than its statutory profit. But at least holders can take some solace from the 6.8% EPS growth in the last year. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. For example, we've found that Huashi Group Holdings has 2 warning signs (1 is concerning!) that deserve your attention before going any further with your analysis.
This note has only looked at a single factor that sheds light on the nature of Huashi Group Holdings' profit. But there is always more to discover if you are capable of focussing your mind on minutiae. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.